Real Estate Chronicle

A blog dedicated to real estate matters, finance as well as general economics and political economics issues. Posts written by Luigi Frascati, B.Econ. Your comments and suggestions are appreciated.

Wednesday, April 23, 2008

The Curse Of The Crude

In 2006 the world's oil rigs pumped out crude at a rate of nearly 85.5 million bbl. a day. They haven't come close since, even as prices have risen to USD 115 per barrel and are forecasted to reach USD 150 per barrel twelve months from today (source: www.oil-price.net ). All of which raises a question of potentially epochal significance: is it all downhill from here?

It's not as if nobody predicted this. Survivalists, despisers of capitalism, a few billionaire investors and a lot of respectable geologists have long cited the middle to the end of this decade as the likely turning point. Governments and the oil industry have typically dismissed such talk as premature. There have been temporary drops in oil production before, after all. In most official scenarios, production will soon rise again, peaking at more than 110 million bbl. a day around 2030.

But the official scenario doesn't seem to hold water - oil if you prefer - anymore. Even taking the 2030 deadline as true, the implication is that the optimists think we have less than three decades to go. But the fact of the matter is that the word from producers is getting gloomier by the day, to the point that many of them openly agree that oil production will never top 100 million bbl per day. The International Energy Agency warns that new capacity additions will not keep up with declines at current oil fields and the projected increase in demand, forecasted at 1.5 percent more in 2008 or 1.3 million barrels a day.

This isn't quite the same as saying that oil production has peaked and is about to start declining sharply. The big issues are not so much geological as political, technical, financial and even human-resource related. All these factors delay the arrival of oil on the market, meaning that production would not so much peak as plateau. But with demand rising sharply, especially from China and India, even a plateau could be precarious.

The world is not running out of oil. There are massive reserves available in the Alberta tar sands, Colorado shale, Venezuelan heavy oil and other unconventional deposits. The problem is that most of this oil is difficult and expensive to extract and even harder to refine, and is not likely to account for a significant share of global production anytime soon.

Almost everybody agrees that the pumping of conventionally sourced oil outside OPEC has peaked already or will peak soon, a reality that even discoveries like the recent 8 billion-bbl. find off the coast of Brazil cannot alter, because production from so many existing fields is declining.

The big question mark is OPEC, which represents the oil powers of the Middle East and a few other big exporters, and which currently accounts for 41 percent of world oil production. Every optimistic scenario assumes that this share will rise dramatically in the coming years. And of course the implication of this is that if things turn out well, North America and Europe will become substantially even more dependent on middle-eastern oil.

Then there is the gloomy view, postulating that Saudi Arabia - OPEC's top producer - cannot pump much more oil than it does now. In fact, in recent times Saudi out put has dropped from 9.6 million bbl. per day to 8.6 million, despite rising prices.

So far the answer from OPEC leaders has been that high prices are the fault of speculators and the falling dollar, not low production. They cite stats after stats showing that there is more than enough oil for sale right now. The price pressure, they point out, is coming from financial participants in futures markets. All this may be true, but the reality of things, however, is that if OPEC members are not able to boost production in the coming years, it will be impossible to keep blaming the traders as prices rise.

Voices are loud out there that cheap oil is the essential fuel of modern capitalism, which will founder without it. On the other hand, a more hopeful take is that innovation is the essential fuel of capitalism, so that high oil prices will drive rapid advances in conservation and alternative energy. Either way, the beginning of the end of the oil era may be upon us well ahead of schedule.